Mankiw's broader point is that since we have seen nothing like this before
except for the Great Depression, we should be humble and risk averse--and hence
have the government stand back and wash its hands of the situation.

Paul Krugman
concurs, adding a sense of urgency to the current situation:

Quite. I really don’t think people appreciate the huge dangers posed by a
weak response to 9 1/2 percent unemployment, and the highest rate of long-term
unemployment ever recorded…

...Right now, I’m reading Larry Ball on
hysteresis
in unemployment (pdf) — the tendency of high unemployment to become
permanent. Ball provides compelling evidence that weak policy responses to high
unemployment tend to raise the level of structural unemployment, so that
inflation tends to rise at much higher unemployment rates than before. And the
kind of unemployment we’re experiencing now, with many workers jobless for very
long periods, is precisely the kind of unemployment likely to leave workers
permanently unemployable.

And there are already indications that this is happening. Bill Dickens, one
of the people has who worked on downward nominal rigidity, tells me that the
Beveridge curve — the relationship between job vacancies and the unemployment
rate — already seems to have shifted out dramatically. This has, in the past,
been a sign of a major worsening in the NAIRU, the non-accelerating-inflation
rate of unemployment.

This recession looks very different, and much more troubling, than those in
the recent past. I wonder how this dramatic change in the nature of
unemployment will alter traditional macroeconomic relationships, such as Okun's
Law and the Phillips curve.

Some research
suggests that the long-term unemployed put less downward pressure on
inflation. If that is indeed the case, then the increase in long-term
unemployment may mean that we will see less deflationary pressure than we might
have expected from the high rate of unemployment. In other words, the
NAIRU may have risen, perhaps quite substantially. This is mostly
conjecture, however. It seems likely we will see more work on this topic
in the coming years.

So Mankiw recognizes the problems posed by protracted periods of economic
weakness, yet in his criticism appears to push for more caution
while overlooking an obvious reason why the impact of fiscal policy was
insufficient to significantly alleviate the recession. It was simply too
small - as economists predicted at the time. Indeed, if he is so
worried about the risk of rising NAIRU, he should be pushing for policymakers to
pull out all the stops.

Mankiw is not alone in seeing the challenges posed by protracted
unemployment. From Federal Reserve Ben Bernanke's
Congressional testimony:

Moreover, nearly half of the unemployed have been out of work for longer than
six months. Long-term unemployment not only imposes exceptional near-term
hardships on workers and their families, it also erodes skills and may have
long-lasting effects on workers' employment and earnings prospects.

The difference between Mankiw and Bernanke is that the latter not only
recognizes the problem, but could also do something about it. Not that he
is inclined to. Of course, he is not alone. Philadelphia Fed
President Charles Plosser was
quoted today:

“Lowering the interest rates closer to zero could have very disruptive
effects on the financial markets,” Plosser said. “If we bought Treasury bills we
could un-anchor expectations of inflation because the public might begin to
think we are going to buy up the public debt.”

Plosser repeats the credibility story, arguing that additional
action as suggested by Joe Gagnon will trigger an inflationary spiral.
Likewise, San Francisco Fed President Janet Yellen
expressed an unwillingness to adopt a new inflation target:

Janet Yellen, President Barack Obama’s pick to be the Federal Reserve’s next
vice chairman, said it would be “risky” to adopt a long-run inflation goal of 4
percent, and that supervision and regulation are “the first line of defense”
against risks to the financial system.

She made the comments in written responses to questions posed by U.S. Senator
Richard Shelby, a Republican from Alabama, following her July 15 hearing before
the Senate Banking Committee. Yellen, president of the San Francisco Fed, is
awaiting confirmation, along with Obama’s other nominees, Sarah Bloom Raskin and
Peter Diamond…

...She said that while a higher long-run inflation goal would “give the Fed
more maneuvering room in the future,” she agrees with Bernanke that such a move
“would be a risky policy strategy.” Most policy makers regard 2 percent as a
level consistent with price stability.

I would think that, despite having to endure a higher inflation target,
Yellen would be eager to have more maneuvering room. After all, there is
not a lot of working room for conventional policy in a liquidity trap. Yet
Fed officials seem to prefer the idea that unemployment becomes a long term
challenge rather than a short run cyclical issue over the risk of inflation.
Like fiscal policy, monetary policy is now limited by imaginary obstacles.

Now I realize that a few anecdotes don't make facts, but I have been in more
than a few conversations with businesspeople who have claimed that the
productivity gains realized in the United States throughout the recession and
early recovery reflect upgrades in business processes—bundled with a
necessary upgrade in the skill set of the workers who will implement those
processes. This dynamic suggests that the shift in required skills has been
concentrated within individual industries and businesses, not across sectors or
geographic areas that would be captured by our most straightforward measures of
structural change.

To be honest, I hear this complaint too, but have trouble swallowing it.
I believed it in the mid and late 1990's, but now? The eight million
people dropped into unemployment are all unemployable? Firms are
willing to lose profits than do the unthinkable, on the job training, actually
invest in their employees? I also have heard the opposite story, of
overeducated temporary Census workers desperate for employment, completing
assignments in a fraction of the expected time, not realizing that their
productivity would only be rewarded with a shorter stint of employment.
And if we are experiencing all these magical productivity gains and a shortfall
of workers, then wages should be rising quite smartly. But from
one of the articles cited by Altig:

Here in this suburb of Cleveland, supervisors at Ben Venue Laboratories, a
contract drug maker for pharmaceutical companies, have reviewed 3,600 job
applications this year and found only 47 people to hire at $13 to $15 an hour,
or about $31,000 a year.

You get what you pay for. To put this into perspective, the
average national wage for Wal-Mart was $11.24/hour in 2009. I would
hope, however, that Ben Venue Laboratories pays better benefits.

I would really appreciate a good story that explained why we should be happy
about high productivity growth if real wage growth is not surging. The
lack of the latter makes me question the reality of the former.

Putting my skepticism aside, if a skills mismatch is really a problem, then
the solution is to ramp up activity until labor shortages raise wages and force
employers to reach deeper into the barrel and in turn bring more people into the
labor force to gain those missing skills. Better to do it sooner than
later. If the productivity gains are real, the wage gains should not
be inflationary. This was the story of the 1990s. Otherwise, policymakers
sit and wait as the potential structural rigidities deepen, thereby ensuring a
higher NAIRU in the future. And, driven by fear of inflation, this appears
to be exactly what policymakers intend to do.

Mankiw's broader point is that since we have seen nothing like this before
except for the Great Depression, we should be humble and risk averse--and hence
have the government stand back and wash its hands of the situation.

Paul Krugman
concurs, adding a sense of urgency to the current situation:

Quite. I really don’t think people appreciate the huge dangers posed by a
weak response to 9 1/2 percent unemployment, and the highest rate of long-term
unemployment ever recorded…

...Right now, I’m reading Larry Ball on
hysteresis
in unemployment (pdf) — the tendency of high unemployment to become
permanent. Ball provides compelling evidence that weak policy responses to high
unemployment tend to raise the level of structural unemployment, so that
inflation tends to rise at much higher unemployment rates than before. And the
kind of unemployment we’re experiencing now, with many workers jobless for very
long periods, is precisely the kind of unemployment likely to leave workers
permanently unemployable.

And there are already indications that this is happening. Bill Dickens, one
of the people has who worked on downward nominal rigidity, tells me that the
Beveridge curve — the relationship between job vacancies and the unemployment
rate — already seems to have shifted out dramatically. This has, in the past,
been a sign of a major worsening in the NAIRU, the non-accelerating-inflation
rate of unemployment.

This recession looks very different, and much more troubling, than those in
the recent past. I wonder how this dramatic change in the nature of
unemployment will alter traditional macroeconomic relationships, such as Okun's
Law and the Phillips curve.

Some research
suggests that the long-term unemployed put less downward pressure on
inflation. If that is indeed the case, then the increase in long-term
unemployment may mean that we will see less deflationary pressure than we might
have expected from the high rate of unemployment. In other words, the
NAIRU may have risen, perhaps quite substantially. This is mostly
conjecture, however. It seems likely we will see more work on this topic
in the coming years.

So Mankiw recognizes the problems posed by protracted periods of economic
weakness, yet in his criticism appears to push for more caution
while overlooking an obvious reason why the impact of fiscal policy was
insufficient to significantly alleviate the recession. It was simply too
small - as economists predicted at the time. Indeed, if he is so
worried about the risk of rising NAIRU, he should be pushing for policymakers to
pull out all the stops.

Mankiw is not alone in seeing the challenges posed by protracted
unemployment. From Federal Reserve Ben Bernanke's
Congressional testimony:

Moreover, nearly half of the unemployed have been out of work for longer than
six months. Long-term unemployment not only imposes exceptional near-term
hardships on workers and their families, it also erodes skills and may have
long-lasting effects on workers' employment and earnings prospects.

The difference between Mankiw and Bernanke is that the latter not only
recognizes the problem, but could also do something about it. Not that he
is inclined to. Of course, he is not alone. Philadelphia Fed
President Charles Plosser was
quoted today:

“Lowering the interest rates closer to zero could have very disruptive
effects on the financial markets,” Plosser said. “If we bought Treasury bills we
could un-anchor expectations of inflation because the public might begin to
think we are going to buy up the public debt.”

Plosser repeats the credibility story, arguing that additional
action as suggested by Joe Gagnon will trigger an inflationary spiral.
Likewise, San Francisco Fed President Janet Yellen
expressed an unwillingness to adopt a new inflation target:

Janet Yellen, President Barack Obama’s pick to be the Federal Reserve’s next
vice chairman, said it would be “risky” to adopt a long-run inflation goal of 4
percent, and that supervision and regulation are “the first line of defense”
against risks to the financial system.

She made the comments in written responses to questions posed by U.S. Senator
Richard Shelby, a Republican from Alabama, following her July 15 hearing before
the Senate Banking Committee. Yellen, president of the San Francisco Fed, is
awaiting confirmation, along with Obama’s other nominees, Sarah Bloom Raskin and
Peter Diamond…

...She said that while a higher long-run inflation goal would “give the Fed
more maneuvering room in the future,” she agrees with Bernanke that such a move
“would be a risky policy strategy.” Most policy makers regard 2 percent as a
level consistent with price stability.

I would think that, despite having to endure a higher inflation target,
Yellen would be eager to have more maneuvering room. After all, there is
not a lot of working room for conventional policy in a liquidity trap. Yet
Fed officials seem to prefer the idea that unemployment becomes a long term
challenge rather than a short run cyclical issue over the risk of inflation.
Like fiscal policy, monetary policy is now limited by imaginary obstacles.

Now I realize that a few anecdotes don't make facts, but I have been in more
than a few conversations with businesspeople who have claimed that the
productivity gains realized in the United States throughout the recession and
early recovery reflect upgrades in business processes—bundled with a
necessary upgrade in the skill set of the workers who will implement those
processes. This dynamic suggests that the shift in required skills has been
concentrated within individual industries and businesses, not across sectors or
geographic areas that would be captured by our most straightforward measures of
structural change.

To be honest, I hear this complaint too, but have trouble swallowing it.
I believed it in the mid and late 1990's, but now? The eight million
people dropped into unemployment are all unemployable? Firms are
willing to lose profits than do the unthinkable, on the job training, actually
invest in their employees? I also have heard the opposite story, of
overeducated temporary Census workers desperate for employment, completing
assignments in a fraction of the expected time, not realizing that their
productivity would only be rewarded with a shorter stint of employment.
And if we are experiencing all these magical productivity gains and a shortfall
of workers, then wages should be rising quite smartly. But from
one of the articles cited by Altig:

Here in this suburb of Cleveland, supervisors at Ben Venue Laboratories, a
contract drug maker for pharmaceutical companies, have reviewed 3,600 job
applications this year and found only 47 people to hire at $13 to $15 an hour,
or about $31,000 a year.

You get what you pay for. To put this into perspective, the
average national wage for Wal-Mart was $11.24/hour in 2009. I would
hope, however, that Ben Venue Laboratories pays better benefits.

I would really appreciate a good story that explained why we should be happy
about high productivity growth if real wage growth is not surging. The
lack of the latter makes me question the reality of the former.

Putting my skepticism aside, if a skills mismatch is really a problem, then
the solution is to ramp up activity until labor shortages raise wages and force
employers to reach deeper into the barrel and in turn bring more people into the
labor force to gain those missing skills. Better to do it sooner than
later. If the productivity gains are real, the wage gains should not
be inflationary. This was the story of the 1990s. Otherwise, policymakers
sit and wait as the potential structural rigidities deepen, thereby ensuring a
higher NAIRU in the future. And, driven by fear of inflation, this appears
to be exactly what policymakers intend to do.